When you have a 401(k) retirement plan, you are in charge of managing your investments. It is up to you to decide the best places for your money. Because of this control, you can use your 401(k) to invest in day trading, just like you could with a regular brokerage account. But first you need to be aware of a few tax differences.
Day trading is an active investment strategy. When you day trade, you constantly buy and sell stocks. Day traders try to earn high returns for their portfolios by tracking financial news, valuing different companies, and predicting the direction of the stock market.
To day trade, you'll need to spend a significant amount of time managing your investments, because you will have to make changes constantly.
401(k) Tax Advantage
Because you can buy and sell stocks whenever you want in a 401(k), you can use a day-trading strategy.
Day trading in a 401(k) has a potential tax benefit over day trading in a regular brokerage account. When you sell a stock for a gain in a brokerage account, you owe tax on your gain right away. When you make a gain in your 401(k), you don't owe taxes on the gain as long as the money stays in your account. This means you can earn a higher after-tax return in the 401(k).
401(k) Tax Disadvantage
The major problem with day trading in a 401(k) is that your withdrawals are restricted. Because the 401(k) is a retirement plan, you are supposed to keep your money in the plan until you are at least 59 1/2.
If you take out money before then, you owe income tax plus a 10 percent penalty on your entire withdrawal, which would ruin your investment return. Because of this tax penalty, you can't effectively use your 401(k) to day trade for a living; it works only for your retirement savings.
Drawbacks to 401(k) Trading
One major concern when trading in your 401(k) is that you risk losing your ability to trade if you inadvertently end up breaking the rules of your plan's excessive trading rules. Aggressive day trading also poses risks because trading based on daily price fluctuations can be difficult. 401(k) trading may not often lead to capital gains, either.
On the flip side, instead of aggressive day trading, you may end up under-trading if you only trade occasionally. Around 87 percent of 401(k) account holders don't end up doing any trading during an entire year. It may be a good idea to periodically check in to make sure your funds are making gains.
Dylan Armstrong specializes in insurance, investing and retirement planning. He has also worked as a life and health insurance salesman and holds a Bachelor of Science in finance from Boston College.